The answer is significant because it affects how an individual reports compensation and pays taxes. Perhaps the greatest single issue this affects is how to report the value of housing provided and/or the amount of housing allowance paid.
The Church of the Nazarene has several different classifications of ministry designations. They are separated on the basis of one or more of the following criteria: experience, training, and calling. Likewise, the United States government has tax laws especially applicable to “ministers.” However, not everyone who might be recognized as a “minister” by the Church would be considered as such by the tax laws. It is the responsibility of the ministerial employee, as well as the church employer, to comply properly with such laws and regulations. The question “Who is a minister for tax purposes?” then is significant. To answer this question, answers are needed to related questions such as: Who do the IRS and tax courts consider to be a minister? To whom does the Church of the Nazarene give authority to perform these “recognized” duties of a minister?
The IRS Definition
The Internal Revenue Service uses the term “Minister of the Gospel” and, in the Income Tax Regulations, elaborates that a minister is one who is “duly ordained, licensed, or commissioned” and who performs service in the exercise of his or her ministry. This includes the ministration of sacerdotal functions, the conduct of religious worship, and the control, conduct, and maintenance of religious organizations (including integral agencies) under the authority of a church denomination.
See Memo #12 - Who is a Minister for Tax Purposes? for more details.
Requirements for business expense reimbursements are based on IRS Regulation 1.62-2(d)(3). These requirements apply to every church and affect all employees. They are not optional—they must be followed, or the church employee may pay significantly greater amounts of unnecessary taxes. The IRS regulations require that business reimbursements be included on Form W-2 as taxable income to the individual unless paid through an “accountable reimbursement plan” which has been “formally” adopted by the church board. The requirements for the accountable reimbursement plan are three-fold: (1) The church may reimburse only those business expenses that an employee substantiates within 60 days of the expenditure with receipts and/or in writing as to the date, amount, place, and business nature. (2) The employee must return any “excess” reimbursements (i.e., unused expense advances) within 120 days of the expenditure. The excess reimbursement may not be treated as a bonus or gift. (3) Any advance must be made within 30 days of when the expense is paid or incurred.
The tax and reporting requirements with which churches must comply often seem to complicate the task of the local church treasurer. Many treasurers who volunteer their services to the church feel the special tax treatment of ministers adds another level of complexity to an already time-consuming task. For a an overview of many of the basic federal tax and reporting issues see Memo #3 - Tax and Reporting Procedures.
The only employee we have besides our pastor is a part-time custodian (or secretary). Do you know of any way we could pay them by contract and save the trouble of withholding income taxes and Social Security/Medicare (FICA) taxes?
Only if they qualify under IRS code, which is unlikely unless they perform similar duties for multiple organizations. For a more detailed explanation see Memo #2 - Church Employees or Independent Contractors?
Across our denomination this difficult question is being asked, often out of genuine concern for the pastor's dilemma at retirement, when he or she has no real estate investment built up for a retirement home. The question becomes even more difficult to answer with the shift in the nation's economy and in each local economic situation. While there is no absolute, authoritative answer, the following are some of the advantages and disadvantages which is offered to stimulate careful thinking and evaluation. For the complete list and a more detailed analysis see Memo #1 - Housing for Your Pastor: Parsonage or Housing Allowance? < /p>
Pro Parsonage and Con Housing Allowance:
1. In some situations, there really is little choice.
The parsonage may be connected to or adjoining the church building with no alternative for selling or renting it.
Unless used for Sunday School rooms, it remains the pastor's home.
2. Churches owning a parsonage may strengthen their ability to attract a pastoral candidate of their choice
who may not be able or willing to buy a home.
3. In some areas, there are no property taxes on a church-owned parsonage, which may mean less expense for the church.
4. The church handles repairs and maintenance on the parsonage, thus freeing the minister from such time-consuming
worries and expense.
5. A parsonage may be nicer than what a minister could afford to buy in some communities.
Pro Housing Allowance and Con Parsonage:
1. A housing allowance may solve the problem of having to build a new parsonage at today's costs,
while at the same time allowing the pastor to save more for retirement.
2. With a housing allowance, some feel that compensation planning may be more flexible, easier to compare,
and simpler to budget.
3. Home ownership suggests permanency and may encourage longer pastorates.
4. A home owner pays real estate taxes and has more voice in community affairs.
5. Purchasing a home allows the minister to choose the location and type of housing preferred.
The Tax Code does provide a means for some ministers in some denominations to exercise an option to terminate Social Security/Medicare coverage for their ministerial earnings. IRS Form 4361 must be used, and it must be filed on the correct basis of religious belief. If approved by the IRS, only earnings from ministerial services are exempt from self-employment tax. Form 4361 indicates that once the exemption is approved, you cannot revoke it.
Use caution. You must agree to the statement below when filing Form 4361:
“I certify that I am conscientiously opposed to, or because of my religious principles I am opposed to, the acceptance (for services I perform as a minister…) of any public insurance that makes payments in the event of death, disability, old age, or retirement; or that makes payments toward the cost of, or provides services for, medical care. (Public insurance includes insurance systems established by the Social Security Act).”The Church of the Nazarene has one of the highest levels of participation in Social Security of any denomination of its size or larger. This has been true since the very earliest days of Social Security coverage for ministers. Most local Nazarene churches have a practice of reimbursing part, if not all, of the minister’s Social Security/Medicare tax, as well as that of lay staff. By practice and polity, there appears to be no basis for an exemption for Nazarene clergy from Social Security/Medicare self-employment taxes .
Can I take a "voluntary reduction" in my salary of 10 percent or more, rather than writing checks back to my church for tithes and offerings?
Most tax professionals agree that a voluntary salary reduction for a church employee in lieu of contributing tithes and offerings does not constitute charitable contributions because the amounts do not "proceed from a detached and disinterested generosity."
While the housing allowance designation for a minister who owns his or her own home provides the maximum housing allowance benefit, almost every minister qualifies for some housing allowance. A minister who rents a home qualifies for a housing allowance to cover the rent, utilities, and furnishings, for example. However, there is not a "non-taxable account" similar to the housing allowance designation.
Determining the fair rental value is solely the responsibility of the minister, and the IRS doesn't give us much help on this issue. The IRS simply tells us the fair rental value should be based on comparable rental values of other similar residences in the immediate neighborhood or community, comparably furnished. (All too often there are not similar residences in the immediate neighborhood or community, comparably furnished!) One of the best methods to establish the fair rental value of your housing is to request a local realtor to estimate the rental value in writing. Place the estimate in your tax file and annually adjust the value for inflation and other local real estate valuation factors.